effectively exposed to the business risk. If the operator experiences a

business loss, as well as the business loss, they will also lose their non

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business assets. Also all taxable income will be assessed in the operator‟s name. There is no opportunity of distributing income to another family member, or charity, or shielding from the high personal tax rates. Currently in N.Z. the top rate of personal tax is 39% on income over $60,000. The rate applicable to companies, and trustees of trusts is 33%. By not incorporating the operator cannot split income between

himself and any other person, (or for example a

company or trust), and would therefore be

disadvantageously treated for tax. A sole trader

operation is definitely unwise. However one could

imagine an individual who had sought no professional

advice, had little cash, had negligible business risk, no

assets at risk, and total net taxable income of under

$38,000, and therefore on the lowest 19.5% tax rate,

considering trading in this format.

2) Partnership

A partnership of individuals has all the disadvantages of

the sole trader, and even greater risk. There is still no

incorporation. This is merely a group of sole traders

operating collectively in business. Each partner is exposed to „joint and several‟ liability. This means an extension of each sole trader‟s potential liability, beyond their own personal exposure. In the event of say one partner‟s business activity causing liability, each of the other partners assets in the Partnership, as well as their other personally owned assets would have to jointly contribute to the losses. In other words one partner‟s

business actions, which have caused loss, can jeopardise all the assets of all the other partners, even if the other partners had no contributing involvement. We have seen how an Upper Hutt legal partnership was destroyed by two, of several partner‟s activities. In the 1990‟s the majority

of professional partnerships (where their professional body permitted) have incorporated. In the year 2002, only lawyers and optometrists are still not yet able to incorporate according to their professional bodies codes. Partnerships of limited liability companies (normally termed joint ventures) if structured wisely by forming an umbrella company to operate the business, are generally considered to be acceptable.

3) Company

Standard Company.

This company provides a basic level of asset protection, because the shareholders have limited their liability through the number and value of shares they have selected. However this limited liability is often diminished by the operator‟s personal guarantees to banks and other major creditors.

This type of company is typified, by being incorporated with a low number of shares, and most often is not well structured, because the directors traditionally own the shares in their own names. As a result of director‟s risk of being pursued for trading recklessly, and/or while the company is insolvent, then the very shares representing the business value, are

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exposed and vulnerable in the event the directors are sued alone or

together with the company in a joint action.

It is much superior structuring, on incorporation to issue say 98% of the

shares to the operator‟s passive family trust, which would be formed on

the same day as the company. This results in:

1) The shares being issued to the trustees of the trust, at the low issue

price of the shares, (which is normally $1 per share, if this is a new

company). This low issue price can be substantiated, because the

company will not yet have traded. Also this low value enables the

gifting of the value of the shares to be achieved in a shorter time frame.

2) The 2% of the shares subscribed for by the directors personally, enable

them to be classified as „shareholder/employees‟. This in turn allows

the directors flexibility to receive some, or all of their remuneration by

way of credited salary after the year end accounts are drafted. On this

portion of their income they can pay „provisional tax‟ (which is payable

in 3 instalments per annum) If they did not follow this method, they

would instead have to receive all income by way of p.a.y.e. income.

3) Realistic protection of assets. The trust is in effect a separate entity,

which is separate from the directors/shareholders. Once 2 years has

elapsed since they have gifted the value of the shares to the trust, then

the total value of the shares is untouchable by any creditors and is free

from litigation.

Companies have limitations in transferring

a share of company profits to other

members of ones family, such as a non

working spouse, children, relatives and

charities. This is termed „income splitting‟,

whereby income is spread, to reduce the

total tax. An individual can only be paid

salary or director‟s fees, for the work

provided, and this work needs to be

justified and is accountable to IRD, should

one be put on inquiry. The only other

method of distributing profits is by way of

paying dividends to the shareholders. Unfortunately all dividends are pre taxed at 33% (the company tax rate),

which is higher than the 19.5% personal tax rate for those persons earning

less than $38,000. The result in this situation is that these shareholders are

not provided with a cash refund of what would seem overpaid tax. The

outcome is therefore often not tax efficient.

If standard companies make a tax loss, then they cannot distribute this loss to

shareholders, unless they are separately registered with IRD as loss

attributing qualifying companies (L.A.Q.C.).

4) Loss Attributing Qualifying Companies (L.A.Q.C.)

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These are conventional registered companies with the Companies Office.

However a special tax registration (L.A.Q.C.) is necessary with the IRD. The

main advantage of this type of company is that during the period when a

company is making a net loss, this loss can be attributed to the individual

shareholder, and thus offset against any other taxable income the

shareholders may have in that same year. The loss is allocated to the

shareholders in proportion to each shareholder‟s holding. In other words a

company with $10,000 loss in a year, with one shareholder owning 25%, and

the other 75%. They would share the loss $2,500 and $7,500 respectively. An

L.A.Q.C. company can only have a maximum of 5 shareholders, although

various members of a family collectively only count as 1 shareholder. These

companies were originally introduced in the 1980‟s to provide an improved

partnership, by allowing any loss to be allocated to the shareholders, year by

year, and at the same time providing limited liability protection for the

shareholders. They were introduced for operators involved with businesses

such as forestry investment. Losses could be anticipated for say 24 years with

an expected profit in year 25. More recently L.A.Q.C. companies have been

utilized to purchase rental properties, which will be expected to make a tax

loss for the initial 8-10 years (caused by primarily by non-cash, depreciation

expense).

One disadvantage is shareholders have to personally guarantee any non

payment of company tax. For example, if a company recorded, and allocated th year and collapsed losses for say 5 consecutive years, made a profit in the 6thin the 7 year. Then no company tax would have been paid, and assuming

the company did not have funds to pay the tax on the profits, the shareholders

under their guarantee would have to meet the payment. If operating this type

of company, it is essential that the directors monitor when the company

changes from loss to profit, and proactively deregister from L.A.Q.C. There is

no other structure for which guarantees are required from shareholders by the

IRD.

The other main disadvantage is that

this structure does not provide any

asset protection for the shareholders.

In other words the people owning the

shares (which represent the value of

the business) still have all the value in

their own names. Because of all the

risks, (including but not limited to,

directors risk) individuals are better

advised not to hold assets in their own

names. The operators of the business

utilizing an L.A.Q.C company are motivated entirely by tax considerations, and not by any asset security.

Shareholders may have the intention of holding the shares personally until the

company turns the corner and starts making profits. Then have the shares

valued and transfer these shares to a family trust. The difficulties encountered

could well be, that because of the delay of several years, the share values will

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have greatly increased. This results in a longer period for the individual to gift the higher value of shares, to the trust. Also the vulnerability from IRDS contesting that the transfer was proceeded with, primarily to achieve tax advantages. This would be hard to argue against, as the individual had claimed the losses during the loss period, and then wanted to use the trust to achieve lower tax through „income splitting‟.

5) Trading Trust with Corporate Trustee

This combination of a trust, operating with a sole corporate trustee, combines the best advantages of a trust and a company. In this structure the company is necessary to „do the business‟ but does this in a trustee role, rather than trading for itself. In a trading trust, instead of having persons acting as personal trustees, they instead become directors and shareholders of the corporate trustee. It is possible to run most types of businesses through this type of trading trust. This structure

provides limited liability for the

trading, and for the individuals

involved in the company. It also

provides a company name as the

trading name.

The main advantages of trusts is

that asset protection can be

achieved, and a trust is the best

vehicle for splitting income

between beneficiaries who can

include spouses, children,

grandchildren, other family

members, long term friends, other

trusts (where there is one or more of the beneficiaries are common, and charities. As long as the beneficiaries income is paid to the beneficiaries, it is unnecessary to justify any payment to the IRD. (see separate paper on Trusts for more detail)

6) Passive Trust with People as Trustees (or Corporate Trustee as

Trustee)

A passive trust is one which owns passive assets. These can include assets such as: home, holiday home, shares in a family trading company, investment shares (but not trading shares), rental properties, fixed assets used in a family trading business, vehicles used in a family trading business (which would be leased from the passive to the trading business). Asset protection is achieved (subject to a gifting program). Also income made by the trust can be „spread‟ to other beneficiaries in a very efficient manner. The trustees of a passive trust can be either people or a corporate trustee. The choice would depend on the number of shares owned and number of land titles and mortgages involved. If there were several registrable titles involved, then a corporate trustee would be the most economical, in the event there was a change of personnel acting as trustees. (see separate paper on Trusts for more detail)

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7) Charitable Trust

A Charitable Trust can provide advantages for certain individuals who have a desire to assist the general communities needs for charitable purposes such as: welfare, health or religion. There are two main alternative types of trusts available. One which has a membership of interested members. The second which is made up of initially the original Board members. These members then vote in (or vote out) additional members. This second variety affords closer control for the initial members. These members can vote for different issues pertaining to the trust. The second One of the main features is that by registering the charity with the Registrar of Companies, the charity obtains legal recognition and status independent of the Board of Trustees. Therefore the individual trustees obtain effectively limited liability status. The charity has to be provided for a large section of the community. Individuals responsible for initiating the charitable trust, can be employed by the trust, but their remuneration must be based on market rates for the type of employment. Other criteria are that the charity must provide that in the event it be discontinued, then the remaining assets have to be provided for an alternative charity with similar aims.

In addition to the registration with the Registrar of Companies, there are two separate registrations available from the Inland Revenue Department. The first is „donor charitable status‟. This provided that donors can receive tax relief for donations made to the charity. The second is „income charitable status‟ whereby income received by the trust (from say business operations or interest, dividends or royalties received) will be tax free on receipt to the charitable trust.

Disclaimer'Considering Commencing a Business in New Zealand’ is prepared by Company

Solutions Limited. It is not intended to be fully comprehensive nor is it intended to be a substitute for individual structuring advice.

Your Company Solutions Limited advisor can update you with the most current

information. Professional advice should be sought before applying the information to particular circumstances. Whilst care has been taken in the preparation of this guide, no liability is accepted for any errors.

Copywrite for this material is retained by the proprietors Company Solutions Limited 412 Lake Road, Takapuna, Auckland, New Zealand. www.company-solutions.co.nz